Bernanke Knew Back in 1988 that Quantitative Easing Doesn’t Work

Ed Yardeni – a former Federal Reserve economist who held positions at the Federal Reserve Board of Governors and the U.S. Treasury Department, and who served as Chief Investment Strategist for Deutsche Bank, and Chief Economist for C.J. Lawrence, Prudential Securities, and E.F. Hutton – notes:

Two economists, Seth B. Carpenter and Selva Demiralp, recently posted a discussion paper on the Federal Reserve Board’s website, titled “Money, Reserves, and the Transmission of Monetary Policy: Does the Money Multiplier Exist?” [Here’s the link.]

[The study states:] “In the absence of a multiplier, open market operations, which simply change reserve balances, do not directly affect lending behavior at the aggregate level. Put differently, if the quantity of reserves is relevant for the transmission of monetary policy, a different mechanism must be found. The argument against the textbook money multiplier is not new. For example, Bernanke and Blinder (1988) and Kashyap and Stein (1995) note that the bank lending channel is not operative if banks have access to external sources of funding. The appendix illustrates these relationships with a simple model. This paper provides institutional and empirical evidence that the money multiplier and the associated narrow bank lending channel are not relevant for analyzing the United States.”

Did you catch that? Bernanke knew back in 1988 that quantitative easing doesn’t work. Yet, in recent years, he has been one of the biggest proponents of the notion that if all else fails to revive economic growth and avert deflation, QE will work.

Yardeni is right. But he’s only got half the story.

On a deeper level – as I pointed out in some detail in March – the Fed is intentionally locking up “excess bank reserves” so that they will not be loaned out into the economy. Specifically, in an ill-conceived attempt to prevent inflation, the Fed has been paying sufficiently high rates of interest on reserves deposited at the Fed by the big banks to encourage banks to lock up their reserves at the Fed instead of lending that money out to borrowers who need it.

So on this level, all the quantitative easing in the world won’t increase lending, because the banks will just continue to stockpile their money.

(On the deepest level, banks actually create credit out of thin air. See this, this and this. In other words, the commonly-accepted process for money creation is false, and banks don’t need any reserves to create credit).

Indeed, multiple lines of evidence demonstrate that quantitative easing helps the biggest companies, but not the little guy or the American economy as a whole.

Ed, what about the ability of QE to keep interest rates low? This obviously is irrelevant to the multiplier effect which you are using as an argument against QE. I think you’re dismissing the role QE has on interest rates, both long and short term.

Andrew P

Bernanke has told us in congressional testimony what QE is for. He said that it is for boosting asset prices in order to maintain the value of bank collateral. In other words, it is designed to keep banks solvent. And QE does NOT lower interest rates. Look at a graph yourself. Every QE episode make interest rates rise slightly. If the Fed wanted long term rates to go down, it would simply set the rate, and pledge to defend it no matter what. The Fed did this in WW II, and it does work.

http://profiles.google.com/sadowskiudeledu sadowski@udel.edu Sadowski

“Seth B. Carpenter and Selva Demiralp:

“For example, Bernanke and Blinder (1988) and Kashyap and Stein (1995) note that the bank lending channel is not operative if banks have access to external sources of funding. The appendix illustrates these relationships with a simple model. This paper provides institutional and empirical evidence that the money multiplier and the associated narrow bank lending channel are not relevant for analyzing the United States.”

As enumerated by Frederic Mishkin there are nine monetary transmission mechanism channels of which the Bank Lending Channel is only one, and one of the least important.

How does Yardley go from the fact that Bernanke stated that the “narrow” bank lending channel is not relevant to the conclusion that Bernanke knew that QE doesn’t work?

Bernanke and Blinder weren’t even discussing non-conventional monetary easing in their paper – they were arguing that banks should have different policy targets for monetary versus credit shocks. A huge leap by Yardley, uncritically repeated by Washington’s Blog.